What a load of Bollocks

Two promi­nent eco­nom­ics text­book writ­ers have recent­ly writ­ten that the Glob­al Finan­cial Cri­sis (GFC) shows that the world needs more eco­nom­ics rather than less.

Writ­ing in the New York Times, Gre­go­ry Mankiw could see some need to mod­i­fy eco­nom­ics cours­es a bit in response to the GFC, but over­all he felt that:

“Despite the enor­mi­ty of recent events, the prin­ci­ples of eco­nom­ics are large­ly unchanged. Stu­dents still need to learn about the gains from trade, sup­ply and demand, the effi­cien­cy prop­er­ties of mar­ket out­comes, and so on. These top­ics will remain the bread-and-but­ter of intro­duc­to­ry cours­es.” (That Fresh­man Course Won’t Be Quite the Same, New York Times May 23 2009)

Writ­ing on a blog The East Asia Forum, authors Doug McTag­gart, Christo­pher Find­lay and Michael Parkin wrote that:

“The cri­sis has also brought calls for the heads of econ­o­mists for fail­ing to antic­i­pate and avoid it. That idea, too, is wrong: much eco­nom­ic research point­ed to the emerg­ing prob­lem.

More eco­nom­ic research (and teach­ing), not less, is the best hope of both emerg­ing from the cur­rent cri­sis and of avoid­ing future ones.” (The state of eco­nom­ics, East Asia Forum, May 21 2009)

What a load of bol­locks.

The “prin­ci­ples of eco­nom­ics” that Mankiw cham­pi­ons, and the “More eco­nom­ic research (and teach­ing)” that McTag­gart et al are call­ing for, are the major rea­son why econ­o­mists in gen­er­al were obliv­i­ous to this cri­sis until well after it had bro­ken out.

If they meant “Prin­ci­ples of Hyman Min­sky’s Finan­cial Insta­bil­i­ty Hypoth­e­sis”, or “More Post Key­ne­sian and Evo­lu­tion­ary eco­nom­ic research”, there might be some valid­i­ty to their claims. But what they real­ly mean is “prin­ci­ples of neo­clas­si­cal eco­nom­ics” and “More neo­clas­si­cal eco­nom­ic research (and teaching)”–precisely the stuff that led to this cri­sis in the first place.

Neo­clas­si­cal eco­nom­ic the­o­ry sup­port­ed the dereg­u­la­tion of the finan­cial sys­tem that helped set this cri­sis in train. See for exam­ple this New York Times report on the abo­li­tion of the Glass-Stea­gall Act in 1999 “CONGRESSPASSESWIDE-RANGINGBILLEASINGBANKLAWS” (New York Times Novem­ber 5th 1999). The reporter Stephem Laba­ton not­ed that:

The oppo­nents of the mea­sure gloomi­ly pre­dict­ed that by unshack­ling banks and enabling them to move more freely into new kinds of finan­cial activ­i­ties, the new law could lead to an eco­nom­ic cri­sis down the road when the mar­ket­place is no longer grow­ing briskly…

Then he observed that

Sup­port­ers of the leg­is­la­tion reject­ed those argu­ments. They respond­ed that his­to­ri­ans and econ­o­mists have con­clud­ed that the Glass-Stea­gall Act was not the cor­rect response to the bank­ing cri­sis because it was the fail­ure of the Fed­er­al Reserve in car­ry­ing out mon­e­tary pol­i­cy, not spec­u­la­tion in the stock mar­ket, that caused the col­lapse of 11,000 banks. If any­thing, the sup­port­ers said, the new law will give finan­cial com­pa­nies the abil­i­ty to diver­si­fy and there­fore reduce their risks. The new law, they said, will also give reg­u­la­tors new tools to super­vise shaky insti­tu­tions.

This is a very apt descrip­tion of the role of neo­clas­si­cal econ­o­mists over the last 40 years: every step of the way, they have argued for dereg­u­la­tion of the finan­cial sys­tem. Now we have McTag­gart and col­leagues mak­ing the self-serv­ing claim that:

The cur­rent cri­sis is a fail­ure of reg­u­la­tion that calls for not more reg­u­la­tion, but the right reg­u­la­tion.

So the same eco­nom­ic the­o­ry that sup­port­ed the abo­li­tion of Glass-Stea­gall, amongst many oth­er Depres­sion-inspired con­trols, is sud­den­ly going to be able to do a volte-face and tell us what “the right reg­u­la­tion” might be? Garbage.

What is real­ly need­ed is a thor­ough rev­o­lu­tion in eco­nom­ic thought. First and fore­most this has to be based on empir­i­cal real­i­ty, and from this per­spec­tive almost every­thing that cur­rent text­books treat as gospel truth will end up in the dust­bin.

Coin­ci­den­tal­ly, many non-neo­clas­si­cal econ­o­mists whose writ­ings have been put into the dust­bin by today’s eco­nom­ics ortho­doxy will be back on the shelves once more. Min­sky, Schum­peter, Keynes, Veblen and Marx don’t rate a men­tion in in most cur­rent eco­nom­ic text­books; they had bet­ter fea­ture in future texts, or by 2060 or so we’ll be back here again.

Though I’m clear­ly annoyed at Manki­w’s and McTag­gart’s dri­v­el, I’m not sur­prised by it–in fact I pre­dict­ed it (I doubt that they can point to any­thing they wrote pri­or to the GFC that pre­dict­ed it!). I said the fol­low­ing in an arti­cle “Mad, bad, and dan­ger­ous to know” pub­lished on March 12 2009 in issue 49 of the Real World Eco­nom­ics Review:

Despite the sever­i­ty of the cri­sis in the real world, aca­d­e­m­ic neo­clas­si­cal econ­o­mists will con­tin­ue to teach from the same text­books in 2009 and 2010 that they used in 2008 and ear­li­er…

they will inter­pret the cri­sis as due to poor reg­u­la­tion,…

They will seri­ous­ly believe that the cri­sis calls not for the abo­li­tion of neo­clas­si­cal eco­nom­ics, but for its teach­ings to be more wide­ly known. The very thought that this finan­cial cri­sis should require any change in what they do, let alone neces­si­tate the rejec­tion of neo­clas­si­cal the­o­ry com­plete­ly, will strike them as incred­i­ble.

Some­times, I would like to be wrong…

Final­ly, what les­son did neo­clas­si­cal econ­o­mists take from the Great Depres­sion? That the Fed­er­al Reserve caused it via poor eco­nom­ic pol­i­cy. Who do cur­rent neo­clas­si­cal econ­o­mists blame for this cri­sis? The Fed­er­al Reserve of course, for poor eco­nom­ic pol­i­cy:

By 2007, fuelled by the Fed­er­al Reserve’s egre­gious pol­i­cy errors, mar­kets were mov­ing into unsus­tain­able bub­ble ter­ri­to­ry. The Fed by this time had real­ized the prob­lem was get­ting out of hand and had moved inter­est rates up sharply—too sharply—and burst the house price bub­ble. (McTag­gart et al).

But who staffs the Fed­er­al Reserve? Neo­clas­si­cal econ­o­mists of course…

Please, let’s not fall for this non­sense a sec­ond time. Keynes tried to free us from neo­clas­si­cal eco­nom­ic think­ing back in the 1930s, only to have neo­clas­si­cal econ­o­mists like John Hicks and Paul Samuel­son evis­cer­ate Key­nes’s thought and re-estab­lish a revi­talised neo­clas­si­cal eco­nom­ics after the Depres­sion was over. This time, let’s do it right and get rid of neo­clas­si­cal eco­nom­ics once and for all.

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